Get Bullish on Hoppy Williams-Sonoma

by Joseph Hargett | August 28, 2013 9:29 am

Housing goods specialist Williams-Sonoma (WSM[1]) has enjoyed quite a comeback this year, with investors flocking to the company in hopes that it will be caught up in the wake of the improving housing sector. So far, those bets have paid off, with WSM shares rallying more than 39% so far this year.

But the shares have become a bit toppy lately, and the company needs to shine in tonight’s trip to the earnings confessional.

For the record, Wall Street is looking for a profit of 47 cents per share from Williams-Sonoma, with revenue expected to arrive at $940 million. During the past couple of weeks, many analysts have reaffirmed their ratings on the company, though with most of those being “holds,” I’m not sure their reaffirmations are all that inspiring. Overall, WSM has attracted seven “buy” ratings and 20 “holds,” with nary a “sell” rating to be found.

There have been a few price-target increases from the brokerage community, however. In fact, UBS this week boosted its target to $61 per share while lifting its earnings estimates. There is plenty of room for additional increases, however, as the average consensus 12-month price target for WSM currently rests at $57.44 — a discount to the stock’s close at $59.44 on Tuesday.

Elsewhere, short sellers have lined up in droves against WSM. Despite a 3% decline during the most recent reporting period, some 7.38 million WSM shares, or 8.15% of the stock’s total float, remain sold short. Because of this wealth of short interest, WSM could be on the cusp of a potential short-squeeze rally, especially if the company releases solid figures later tonight.

Turning toward WSM’s options activity, we find no signs that short sellers are nervous about a short-term rally in the shares. As I have noted before, short sellers will often buy calls as a way to hedge their positions, especially ahead of volatile events like earnings reports.

WSM, however, currently sports call open interest of only 3,238 contracts in the September/October options series, compared to put open interest of 4,713 contracts. The result is a bearish put/call open interest ratio of 1.45 for the front two months of options.

Peak put open interest resides at the out-of-the-money Sep 55 strike, where 2,638 contracts reside. Another 1,121 puts are open at the in-the-money Sep 60 strike. Meanwhile, peak call open interest totals 1,533 contracts at the overhead Sep 62.50 strike, with another 1,050 calls open at the Sep 60 strike.

Drilling down on WSM’s September options reveals that implieds are pricing in a potential post-earnings move of roughly 7%. This places the upper bound near $64.35, with the lower bound near $55.65.

Click to Enlarge Technically speaking, the $64-$65 region (home to the upper bound) could emerge as short-term resistance for WSM, especially considering that the stock would be trading in all-time high territory. On the other hand, the $55 region (home to the lower bound) should hold firm as technical support, with WSM’s 20-week moving average moving through the area. That said, first support should emerge near 58, which is home to the stock’s 50-day moving average.

Traders looking to open a position on WSM ahead of tonight’s quarterly report might want to consider a contrarian trade on the stock. With plenty of short interest, uncertainty from Wall Street analysts, and pessimism from the options crowd, it would appear that any bad news that Williams-Sonoma might report is already anticipated. As such, the bar for exceeding expectations looks like it is set pretty low.

To take advantage of this low-water mark, traders might consider entering a Sep 57.50/65 bull call spread. At the close of trading on Tuesday, this spread was offered at $3.05, or $305 per pair of contracts. Breakeven lies at $60.55 (1.9% above yesterday’s close), while a maximum profit of $4.45, or $445 per pair of contracts, is possible if WSM closes at or above $65 when September options expire.

As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.